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The Collapse of Enron. Sociology 114 Joshua Wakeham March 27 th , 2013. The Rise of Enron. In 1985, in the midst of the deregulation of the gas market, Ken Lay founds Enron. 1990s: Financialization of gas markets Expanded into other utilities, other countries

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the collapse of enron

The Collapse of Enron

Sociology 114

Joshua Wakeham

March 27th, 2013

the rise of enron
The Rise of Enron
  • In 1985, in the midst of the deregulation of the gas market, Ken Lay founds Enron.
  • 1990s:
    • Financialization of gas markets
    • Expanded into other utilities, other countries
    • Shift to “Asset Light” strategy (Skilling)
the peak
The Peak
  • From 1996 to 2000, Enron reported net income rising from $580 million to $970 million.
  • While revenues from traditional physical assets slowed during this time, revenue from trading grew enormously: 1999--$40 billion, 2000--$100 billion.
  • Why did Enron’s executives (Skilling, Lay, others) think that they could get away with this?
  • Why did the accounting firm allow Enron to get away with such questionable accounting practices?
  • Why did investment banks and other partners (Merrill Lynch, Citibank, Deutsche Bank, and so on) let Enron get away with this financial shell game?
  • Why did the SEC—and the government in general—fail to detect Enron’s fraudulent practices?
  • Why did the media and the business world get sucked into this image of Enron as a brilliant, unstoppable success story?
  • Why didn’t any of Enron’s employees speak up?
what went wrong
What went wrong?
  • There are several things we need to account for in order to understand what went wrong at Enron:
    • Business practices:
      • Mark-to-Market Accounting
      • Special Purpose Entities (SPEs)
    • The complicity of external auditors
    • Enron’s culture
  • KEY: As we examine the case, we should be asking is this simply a case of people acting unethically—that is, knowingly violating a shared standard for moral behavior—or is it a case in which the circumstances themselves shaped (and distorted?) people’s moral evaluations of their own behavior?
understanding enron s financial shell game
Understanding Enron’s Financial Shell Game
  • Understanding why Enron did so well in the market for so long requires understanding the role of appearances in the market.
    • Investors, business partners look for particular pieces of information in order to determine the financial health or worthiness of a company.
    • Accounting  Assurance about the Information?
  • Enron’s accounts of key financial measures signaled to investors and the broader business community that the organization was doing quite well.
  • However, in actuality, Enron’s “creative accounting” disguised losses, expenses, and risks and inflated earnings, assets, and value.
mark to market accounting
Mark-to-Market Accounting
  • When trading commodities that have prices that fluctuate, it is often difficult to determine the real value of a transaction.
  • Enron lobbied to use present value accounting on its long-term contracts.
special purpose entities
Special Purpose Entities
  • SPEs are supposed to be third-party, independent legal entities created to serve a specific purpose for a company (such as securitization of debt, risk sharing, tax avoidance).
  • Enron developed hundreds of SPEs under CFO Andrew Fastow.
  • SPEs would primarily buy or take on debts and expenses from Enron, essentially changing their status in Enron’s books from costs to revenues.
enron s shell game
Enron’s Shell Game
  • Enron’s increased reliance on increasingly complex financial tools arguably led it to a place where questionable, if not outright fraudulent and corrupt practices, were acceptable.
  • By its peak, Enron had constructed a completely false account of its financial standing. Debt and costs were hidden in SPEs. Mark-to-market accounting allowed the company to basically make-up its earnings.
  • With things going so well, no one questioned why or how. Not even the people who were supposed to.
complicity from the outside
Complicity from the Outside
  • An important part of the Enron story is the role of outsiders in propping up Enron’s falsely constructed version of its success.
  • The list of complicit players includes:
    • Arthur Anderson, Merrill Lynch
    • Various investment banks and financial firms
    • The government
why did outsiders approve
Why did Outsiders Approve?
  • Easy answer: Most had a financial (or political) interest in doing so.
  • Another problem: Skilling and others were really smart and what they were doing was really complicated.
    • How Enron made its money was intentionally kept opaque to outsiders.
    • Skilling et al. played up an intimidating image of “we know better.”
  • The cost of complicity: Approval by these high status outsiders fueled the confidence of people outside of Enron (including workers with 401k’s) and the confidence of people within Enron. If the SEC, investment banks, and the accountants approved what we were doing, how could it be considered wrong?
looking inside enron
Looking Inside Enron
  • Another key part of this story is Enron’s unique business culture.
  • Enron cultivated an image of a company that rewarded talent in a highly competitive environment.
  • KEY: The Performance Review Committee
    • Grading employees on a curve: “Rank and yank”
    • Along with critical system was the potential for huge financial rewards in the form of bonuses.
    • Lessons from Moral Mazes?
  • The business community ate this up (e.g. HBS).
enron s leadership
Enron’s Leadership
  • At the top of this competitive organizational culture were a group of executives who cultivated an image of being macho, smarter-than-you risk takers.
  • Under such conditions and under such leadership, who would dare dissent?
  • Was it too little, too late?
  • How would Jackall, using Moral Mazes as a framework, want us to think about the Enron case? How is this different than someone who might teach a “business ethics” course?
  • Do you think that the various people at Enron knowingly violated ethical principles that they held, or did circumstances change what it meant to do good business?
  • How is Enron a harbinger of things to come?